I haven’t seen a great primer on how COVID-19 impacts the businesses underlying stocks, so I’m putting down my thoughts here. Some key points:
- It is now pretty clear that it will disrupt the economy. Even if governments do not implement extreme measures, many consumers will. Most people will not go to retail stores and cinemas, causing them to have so few customers that they might as well close down.
- The virus has been successfully contained in China, South Korea, Hong Kong, Taiwan, Singapore, and Macau. These countries are working towards easing their restrictions and having life return to normal. In those countries, the worst has passed.
- Practically everywhere else, the virus is quickly spreading and is not being contained.
- The world is not ending. This is not the Spanish Flu and even that calamity did not cause stock prices to fall.
What happens if the virus is uncontrolled?
In the Spanish Flu pandemic from January 1918 to December 1920, roughly 27% of the world’s population was infected and 17 to 100 million people died (see Wikipedia). Despite the terrible human cost, the stock market went up in that timeframe. One could argue that other factors played a role in stock prices going up (e.g. low valuations, end of World War 1). Nonetheless, stock prices survived the terrible event.
With the H1N1 virus or swine flu, the virus infected roughly 11-21% of the world population. However, because its lethality is comparable to typical seasonal flu, it did not turn into a health problem.
The lethality of coronavirus is somewhere between that of seasonal flu and definitely lower than the Spanish Flu. The mortality rate is almost certainly less than 1%, although hospitals operating above their capacity would increase the mortality rate. While the World Health Organization estimates mortality at 4%, John Ioannidis makes an argument that their figures are biased too high; those who survive the virus often do not get tested and don’t show up in the statistics. I think that the exact mortality rate isn’t too important because we know enough about the virus to know that it is problematic. To quote an article responding to Ioannidis’ opinion:
In Italy, coffins of Covid-19 victims are accumulating in churches that have stopped holding funerals. In Wuhan, at the peak of the epidemic there, critical cases were so numerous that, if scaled up to the size of the U.S. population, they would have filled every intensive care bed in this country.
So regardless of the true mortality rate (which will become clearer in the future), COVID-19 is a serious problem. In most countries around the world, the current containment efforts are not working. So either:
- The virus becomes widespread in that country and its hospitals overcrowd.
- Countries around the world step up their efforts to contain the virus.
EDIT: In a real-world scenario, the mortality rate may be much higher than 1%. If patients are put on a ventilator, then the mortality rate is likely below 1%. But if the virus spreads exponentially, then there will not be enough ventilators and patients will not receive proper treatment. I don’t believe we have data on patients who are not put on a ventilator. There would be a lot of deaths in that scenario.
Every country is trying to contain the virus in different ways
The reality is that countries around the world have very different strategies in dealing with the virus. This likely explains why only a handful of countries have been successful in containing the virus.
- Masks: The US and Canada are biased against wearing masks in public. The reasoning is that the limited availability of masks should be reserved for medical staff and people who are sick. In many Asian countries, most healthy citizens are wearing masks and they understand that the “proper” protocol is to throw away masks after using them for a day.
- Closing borders: Hong Kong was able to contain the virus without closing its border to China because Hong Kong’s unpopular puppet government chose not to close borders. Some countries allow travel as long as the traveller enters a mandatory quarantine. Quarantine is more effective if there is a system in place to ensure that travellers actually stay quarantined. Taiwan for example uses phone tracking.
- Widespread testing: South Korea has the capacity to perform many tests for the virus while other countries lack the capacity.
- Temperature checks: In China, citizens have their temperature checked as it is an indicator of fever. Temperatures are taken before people are allowed to shop, eat at a restaurant, to take public transportation, etc. etc. A no-touch infrared thermometer can be used to check temperature.
- Hand washing and cleaning: Many Asian countries practice frequent hand washing and cleaning.
- Bans on large events: Some countries were quicker in implementing these than others.
- School closures: Taiwan has successfully contained the virus without closing its schools. Children go to class with masks and have a barricade in front of them.
- Social distancing.
- Free or low-cost testing. Some countries make it easier to get tested and have the capacity to screen a very large number of citizens.
- Specialist facilities and staff for testing. One issue with getting tested is that somebody who doesn’t know if they have COVID-19 might go to a doctor’s office and accidentally infect others because the staff at the clinic did not correctly implement the best practices for preventing the spread of infection. In South Korea, you can drive to a special clinic in your car and get tested without having to leave your car.
I don’t know what the best strategies are, but there are clearly countries with completely opposite practices on some of these issues (e.g. Hong Kong did not close its borders early on). But as far as investing goes, we don’t need to know what the best practices are. We can simply predict that many countries will pick the wrong practices since containment strategies are all over the place. (Or, they may lack the infrastructure and expertise that other countries do.) If success follows some type of bell curve distribution, then there are going to be some outlier countries with an uncontrolled COVID-19 problem.
The virus’ aftermath will likely go on for at least several months
If I am right about a small handful of countries failing in their attempts to contain the virus, then this virus is going to stay in the news for a while because it exists in a random corner of the world. That is enough to seriously impact some businesses. Some people will be scared to go on vacation. There are many airlines and cruise ship companies that are highly sensitive to small changes in supply and demand (e.g. if they have too much leverage). Airlines have repeatedly gone bankrupt because of small shifts in supply and demand due to events like SARS and 9/11. Some of those companies may face a very real risk of bankruptcy. Retail is also fairly sensitive to foot traffic. Retailers are often locked into long-term leases so much of their operating costs will not come down. Even if the virus is contained, bricks and mortar stores will likely see less consumer spending.
“Science” is a myth
Note that the “science” on health and safety is a cultural thing. The Japanese eat raw pork and chicken while most Western countries only eat raw beef, raw pork if it’s prosciutto, and sushi. It doesn’t really matter if Japan is right or if Western countries are right. What matters is that somebody is probably wrong. Differences in “scientific” opinion exist due to culture.
Or let’s take a look at the World Health Organization. It has been heavily criticized for classifying a transgender sexual orientation as a mental health disorder. It has plans to remove that mental health disorder in the future. This is obviously an unscientific and political decision. If the science is clear, then the delay makes no sense. If the science is unclear, then the delay still makes no sense. Another example is China’s ruling party using its clout to block Taiwan from participating in the WHO because China has a policy of denying Taiwan’s existence as an independent country. This is obviously unscientific and has led to other countries lobbying the WHO to allow Taiwan to participate. Politics clearly get in the way of the WHO fulfilling its mandate.
Politics and culture will likely cause some countries to march to the beat of their own drum. Western countries tend to have a science worship culture that may delay their implementation of effective containment practices, whatever they are. This will cause differences in how effective containment efforts are.
When will life go back to normal?
I don’t know. In most or all human beings, the virus has an incubation time of 2 weeks. Once 2 weeks pass, we will find out if previous efforts were good enough. If not, then hopefully governments intervene, citizens change their mindset, and/or citizens actually do what they’re supposed to do (e.g. not go to large events).
Culture will affect how governments and citizens respond. Where I live in Canada, government officials and the majority of citizens are against healthy people wearing masks. I can’t predict if our culture will shift in response to more widespread COVID-19 infections.
Perhaps a bigger cultural issue is how people feel about “draconian” containment measures, bowing to fear mongering, and irresponsibly inciting panic in the population. If governments act decisively, they may be seen as irresponsibly inciting panic or hurting the economy unnecessarily. Whereas other countries have taken quick and decisive action in fighting the virus, my government and fellow citizens have not been united in taking the virus seriously.
Currently, it would be socially acceptable for returning Canadians to go to the mall or a restaurant (even though my government is supposedly asking visitors not to do this). I would not be surprised if Canada fails to effectively contain the virus in the next few weeks. The current containment efforts have not worked and it may take time for the culture to change and/or the government to enforce the rules. I don’t know how long it will take for all of Canada to take the virus seriously. (Of course, there have been many Western corporations and citizens who have been proactive in cancelling large events and engaging in social distancing.)
The best outcome is if governments and citizens unite in containing the virus while minimizing the economic impact. They could keep borders open but take serious measures in quarantining visitors and using resources to ensure that visitors stay quarantined. They could throw money at building out the capacity to make masks and to build the right infrastructure for handling infectious diseases. We could close down all stores except for supermarkets and pharmacies so that citizens get the point and start taking things seriously. So while it is possible for Western countries to take the pain now and to contain the virus in a month, it may take longer due to culture, politics, and social posturing.
The experience in China- the worst is over
When the outbreak started, the Chinese government did not realize the severity of the situation (especially given how new the virus was) and the situation got out of hand. One could argue that the situation was mishandled at first. Regardless, the Chinese government went on to implement measures that Westerners consider to be draconian. Factories were shut down, supply chains have been disrupted, and people were out of work. Now that containment measures are working, the government is slowly easing restrictions. Factories have restarted although many of them do not operate at full capacity (e.g. some workers can’t get to work). Shops are re-opening though foot traffic is much lower. Apple stores are open in China but closed everywhere else.
We’ll see how long it takes for Chinese factories to get back up to full capacity, for shopping to go back to normal levels, and for life to return to normal.
China’s experience informs us that the coronavirus situation can be contained within a few months if countries handle it with “draconian” measures. It is likely possible to contain the virus with tactics that are less disruptive to the economy as shown by Taiwan, Hong Kong, and South Korea.
Possible opportunities in the stock market
The stock markets’ reactions have been inconsistent
Despite China taking delayed but decisive actions against the virus and seriously disrupting its economy in the process, the SSE Composite Index has stayed relatively flat over the past year. Other stock markets have reacted with full-on panic and irrational trading.
The spreads on certain arbitrage trades are at historically high levels. The LSXMA / SIRI arbitrage trade has a pretty wide spread, though I haven’t had the time to update my Google sheet on it.
The luxury goods retailers TPR and CPRI are trading at very depressed levels (e.g. trailing P/E 6.5, 3.3) relative to branded retailers like AEO (P/E 13.4), GPS (P/E 8.5), Estee Lauder (P/E 26.1), VF Corporation (P/E 15.2), etc. There are other comps like UA (P/E 36.4), GOOS / Canada Goose (P/E 23.57), LULU (P/E 32.6), ATZ / Aritzia (P/E 13.6) which have higher growth and deserve higher multiples. Then again, I could be wrong about TPR and CPRI. It is possible that their leverage gets them into trouble.
In the restaurant space, you can buy Canadian royalty funds like A&W Revenue Royalties Income Fund, with a (trailing) yield of 7.82%. The stock cannot lose money on its royalty and has a 60M credit facility that it needs to pay interest on (the market cap is $250M). There is also Boston Pizza Royalties Income Fund BPF-UN.TO, with a trailing yield of 15.4%, less growth, and more debt. The royalties seem interesting compared to McDonald’s, which has an earnings yield of 5.7% and is a highly leveraged real estate company with negative book value.
YUMC stock has largely gone sideways (its operations are in china) while other restaurant stocks with operations outside China have fallen dramatically.
Because there is insane volatility in the markets at the moment, you may see some intraday opportunities where a stock randomly trades down or up a large amount. For example, Pretium resources traded below $4.25 and above $7.25 in the past few days. It had insane price moves that were disconnected from its fundamentals.
*Disclosure: I am biased because I am long LSXMA, SIRI calls, TPR, CPRI, ATZ / Aritzia, AW-UN.TO, BPF-UN.TO. I reduced my Pretium short slightly (I own puts).
Quality companies that should have very little coronavirus exposure on the downside
Facebook is one of the hottest growth stocks at the moment. If you screen for stocks based on revenue growth, Facebook should appear near the top of your screen. Its current P/E is 22.9, and is less than 22.9 if you adjust for its substantial cash. The company should do well regardless of coronavirus because online shopping and online interactions should be resilient. Google is another hot growth stock (P/E 22.2) trading at multiples well below AMZN, NFLX, and the startup bubble stocks (SHOP, SQ, MDB, BOX, etc.).
To be fair, these aren’t the greatest prices. But, they are fairly reasonable prices for stocks with extremely high growth.
Food companies that are not restaurants should be unaffected. In a draconian Hubei-style lockdown, citizens will be allowed to buy food at a supermarket (every few days) because obviously citizens need food to survive. I can’t tell you which food companies are the best at the moment.
There are also subscription businesses like CHTR / LBRDA, SIRI / LSXMA, etc. Sirius XM has a P/E of 23.75 and is cheaper if you buy it through LSXMA (37%???). It is a monopoly that has continued to grow. Charter (CHTR) is a little complicated so I won’t address it here.
Drug companies and health insurers should not be affected much by coronavirus. Citizens will definitely need to buy drugs and will have access to discretionary drugs like Pfizer’s Viagra (it is one of the ways that citizens can entertain themselves without going out). I do not know which ones are the best at the moment.
*Disclosure: I am biased because I own FB, GOOGL, LSXMA, LBRDA, TSN, SUPN, CNC, UNH.
Lenders are sensitive to the unemployment rate and currently unemployment is much higher because people who work at restaurants, movie theatres, etc. have no jobs at the moment. Historically, the best time to buy these companies is when everybody is scared and these companies cannot get credit. We are not that the point right now but it may happen in the future. Examples include subprime auto lenders (e.g. CACC), subprime lenders that operate retail stores (e.g. RCII), credit card companies that lend to customers (e.g. AXP), loan shark companies (e.g. WRLD), etc. etc.
Stocks that are not undervalued
This is just my opinion, but I think that the sharp drop in airline stocks reflects their drop in value. Recall that Air Canada went bankrupt in 2003 due to 9/11 fears, SARS, and/or the Dot-Com Bubble bursting. While the travel fears were not justified, the drop in customers was real. Such factors were enough to push the airline into bankruptcy.
*Disclosure: I am short AAL, DAL, and AC.TO (Air Canada). I am trying to short CHR.TO. I do not know what I’m doing.
Oil and gas stocks
Oil is trading at extremely depressed prices at the moment (below $30?). Because these companies are leveraged to the price of oil, their low stock prices make sense.
This website has a great compilation of statistics such as the # of new cases in each country. If the number of new cases is dropping, then it is likely that the country is successfully containing the virus. While some people argue that data from China is unreliable, other countries have data that indicates effective containment.
Coronapocalypse – some thoughts – Lyall Taylor argues in favour of buying the dip.